Ericsson, upon whose shares he bestows a $15 price target, should see gross profit margin improve in 2014 based on greater sales of software into cellular networks running the “long term evolution — advanced,” or LTE-A, standard, and higher-margin router sales:

An LTE-A driven increase in data rates will be important for operators seeking to deliver compelling real-time rich communication services (RCS) such as video chat. Packaged video content will also be economically delivered to mobile devices over LTE-A. Ericsson has developed, and is shipping 3GPP Release 10-based LTE-A software to run on all its RBS 6000 series base stations. Among the LTE-A infrastructure software features, we believe enhanced support for carrier aggregation (CA) is the key driver for near term operator adoption. CA is the technology that allows operators to virtually join disparate LTE bands to improve their network capacity and throughput rates. Right now there are ~38 LTE frequency bands; LTE- A allows many of those bands to be virtually combined to create fatter, faster radio pipes. Since it is a software sale, we assume the upgrade cycle for LTE-A will mirror the HSPA cycle where gross margins reached the upper 30% range. We believe Ericsson is well positioned to leverage its strong LTE RAN share into higher margin capacity LTE-A software sales over the next several years.

Hoffman’s view is somewhat in contrast to a view expressed today by Societe Generale’s Andy Perkins, who raised his rating on Ericsson shares precisely because he thinks the company will forego some market share in order to preserve profitability.

Indeed, Hoffman’s profit estimate for Ericsson is below that of Perkins’s, at 5.98 per share in adjusted profit, in Swedish Kroner, in 2014, versus the kr6.82 that Perkins models.

Ericsson will be moving away from relying on Juniper for router products with the advent of LTE-A, he writes:

Historically, Ericsson has partnered with Juniper to provide it with the routers which were integrated into Ericsson’s mobile core SGSN and GGSN offerings. With the move to LTE-A, IMS and EPC, Ericsson made the decision to transition to its internally developed Smart Services Router (SSR) to be the backbone of its IMS and EPC offerings. The company has indicated this move to SSR will allow Ericsson to capture a much larger share of the high margin dollar available on mobile core contracts and better integrate value added services around including IP voice (VoLTE) and enhanced data services.

Regarding Juniper, Perkins assigns a $28 price target, while acknowledging, “Juniper has struggled with gross and operating margin pressures the last few years, the result of high profile product introductions, weak performance from its security portfolio and reduced traction with its long term partner Ericsson.”

But Hoffman thinks an upgrade cycle is afoot in core routing that will benefit the company’s refreshed product line:

Rapid mobile data growth and Internet video traffic puts growing pressure on networks, particularity the core where service provider investment has lagged access and the edge in recent years. Beginning in 2011, Juniper announced a number of product refreshes and new products aimed at seizing the impact those traffic changes were having on its equipment end markets. Major launches included: T4000 (core router), which began shipping in 4Q11 with more meaningful revenue contribution in 2H12; PTX (packet transport switch), which began shipping in 1Q12; QFabric (data center switching architecture), with the top of rack switch shipping in 1Q11 and the full architecture available in 3Q11; ACX edge router (sales are apparently still minimal); MobileNext (evolved packet core software); which began shipping in early 2011 but was discontinued in August 2013; Ultimately, the company‟s moves to upgrade its product line-up should benefit Juniper‟s core routing business. Perhaps it has, given the last two quarterly reports (PSD Routing, +14 and 22% Y/Y in 2Q13 and 3Q13, respectively) and management‟s hopeful indications they expect to see a pick-up in core routing in the coming quarters. At this point we see the sales/order trends as more cyclical than structural and believe core will lose relative wallet share to other areas of the network over time as new technologies trim sales at the margin. We do see Juniper participating in the upcoming SDN cycle, offsetting the impact of that technology on its business.

The company has “mildly” embraced the phenomenon of software-defined networking, or SDN, with products such as Contrail. That could be a plus for the company, although longer-term, SDN poses a risk to router product margins.

Hoffman discusses how the company may be affected by a related development, “network function virtualization”:

Juniper has begun to discuss NFV within the context of its Contrail launch. However, because NFV as an overarching initiative is operator-led and carries risks and costs for software vendors – with an uncertain pay-off – we expect most software or appliance vendors (and many OEMs) to be slow to push into NFV. Thus, unlike IMS and SDN, we are less inclined to believe NFV will be widely implemented in the short or medium term. Certain applications, like Juniper‟s cloud security software, is the type of software well positioned for NFV, but most network appliances will not port so easily – thus we see minimal impact to Juniper from NFV in the forecast period.

As for Cisco, to which he assigns a $23 target, it’s an open question whether Cisco will benefit from that core routing upgrade cycle or be hurt by the move to SDN:

This is how we frame the CSCO stock discussion: Bulls believe a new core networking cycle is imminent as network traffic increases while bears see Software Defined Networking (SDN) in its many flavors removing the key forwarding functions from switching and routing products. Our view is SDN will emerge in data centers first, but will take years to be implemented in service provider networks. We see the main impact for Cisco from SDN will be long term margin pressure.

For the moment, Cisco’s results are “lumpy,” which will weigh on the stock, and growth is uncertain. He likes what the company has done to capitalize on the mobile computing phenomenon, but he thinks Cisco needs to be in the radio access network equipment business, something CEO Chambers has referred to in recent remarks:

Over the past several years Cisco has added capabilities through acquisition in the mobile packet core (Starent), enterprise WLAN (Meraki), licensed small cell (Ubiquisys), and self-optimizing network software (Intucell). However, despite this increased focus on mobility, we believe Cisco remains at a disadvantage due to its lack of macro radio access network (RAN) products as base station transceiver, application layer and control functionality become bundled sales – especially internationally.

As far as Nokia, Hoffman assigns an $8 target, arguing that the company will be cash rich, but that its stock is fully valued so long as it’s not clear what Nokia intends to do with the cash:

(~$10.0bn) by the time both deals close in 1Q14. The company will also have adjusted EPS in C14 of $0.33 (€0.24) on revenue of $16.9bn (€12.5bn). Our view is the new strategy is a clear improvement, but with an EV just under $20bn, a projected EV/R ~1.2x post deal on CY14 revenue, ahead of Ericsson’s 1.0x, and enough uncertainty around Nokia’s strategic direction from here – specifically what it does with its cash pile – that we rate the shares Neutral and see the shares as fairly valued at the current price.The key variable on Nokia stock from here is what Nokia will do with its newly enhanced cash pile. We see three possibilities for Nokia from here: 1) buy a wireless networking company that could bring scale – but might hurt margins 2) return the part of the proceeds from the Devices sale to shareholders or 3) sit still. Since it is somewhat subscale in Networks – and has done well with the Motorola acquisition – we suspect an acquisition is most likely from here. We would look to get more constructive on the shares if management gets more aggressive returning excess cash to shareholders but with fear of a dilutive acquisition we rate shares Neutral.

Ericsson shares today are up 4 cents at $11.98. Nokia stock is down 17 cents, or 2%, at $7.75. Juniper shares are down 22 cents, or 1%, at $21.37. And Cisco stock is down 37 cents, or 1.7%, at $20.84.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.